RESEARCH & KNOWLEDGE MANAGEMENT. Russia and Central Asia Macroeconomic Outlook 2017

Transcription

1 RESEARCH & KNOWLEDGE MANAGEMENT Russia and Central Asia Macroeconomic Outlook July 217

2 Russia and Central Asia Macroeconomic Outlook 217 Contents: 1. Introduction 5 2. Kazakhstan 7 3. Russia Armenia Belarus Kyrgyz Republic Tajikistan 3 8. Turkmenistan Uzbekistan Conclusion 39 2

3 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 1Q17 Russia and Central Asia Macroeconomic Outlook 217 Key highlights: Central Asian economies have started recovering after a downturn in 215 and 216 due to unfavorable external conditions that have affected the countries of the region. Consequently, the majority of regional economies are expected to show stronger performance in 217 and 218, led by Armenia, Kazakhstan, Turkmenistan and Uzbekistan. 15 GDP growth, % ( f) E 217F 218F Source: IMF, Samruk Kazyna Armenia Belarus Kazakhstan Kyrgyz Republic Russia Tajikistan Turkmenistan Uzbekistan Growth in the region is supported by a rebound in commodity prices, as well as improved performance of the Russian economy and strong growth in China. Perspectives of the Russian economy have improved, the economy is expected to show growth of 1.4% in 217 vs. -.2% in 216 and -2.8% in 215. Russia is the key source of remittance flows and the largest trade partner for most of the economies of the Central Asian region. Real GDP growth in Russia, % ( ) Source: Federal State Statistics Office of Russia, Samruk-Kazyna At the same time, growth of the Chinese economy, a key investor and increasingly important trade partner for the region, is forecasted to remain strong. This positively affects growth perspectives of Central Asian countries through improved capital and trade flows, as well as through higher commodity prices. One of the most promising economic developments in the region is the Chinese One Belt One Road initiative, which will focus on strengthening connectivity and promoting infrastructure development. Integration of Armenia, Belarus, Kazakhstan, Kyrgyzstan and Russia within the Eurasian Economic Union will provide additional 3

4 GDP per capita, USD Russia and Central Asia Macroeconomic Outlook 217 economic benefits through the expansion of trade and capital flows, as well as free movement of the labor force. 1, Nominal GDP and GDP per capita (216e) 8, 6, 4, 2, Nominal GDP, USD bln Source: IMF, Samruk Kazyna Armenia Belarus Kazakhstan Kyrgyz Republic Tajikistan Turkmenistan Uzbekistan The IMF estimates economic growth in the Central Asian region at 2.4% in 216,.8% lower than in 215. In 217, higher global commodity prices will support fiscal expansion in oilexporting economies, while the devaluation of most regional currencies will support net exports. Overall growth in the region is projected to pick up to 3.1% in 217 and further accelerate to 4.1% in 218, although individual countries will grow at different rates. Inflation will be subdued in most of the regional economies due to a high base of 216. Nevertheless, most economies of the region are faced with internal and external imbalances, which will require adequate response from the governments through monetary, fiscal and structural policy measures. Some countries would have to implement further fiscal consolidation, adopt more accommodative monetary policy and enforce institutional reforms to ensure a fast recovery and sustainable growth in the future. Consequently, growth of several regional economies will remain subdued due to constrained internal demand and investment activity. At the same time, the respective governments have limited resources and instruments to resolve imbalances. Fiscal space in most of the countries has been diminishing and external debt has been growing as a result of stimulus packages implemented in 215 and 216 to offset the impact of external shocks. Current account deficits widened in most CA countries in 216 as well, largely reflecting the effects of the various external shocks that have hit the region since 214. Most of the Central Asian countries have devalued their currencies due to extensive external shocks and the devaluation of the Russian currency. This has triggered various fiscal and monetary shocks, increasing external debt and inflation. At the same time, financial sector vulnerabilities continue to increase, as dollarization remains high and some banks remain undercapitalized. 4

5 GDP per capita, USD Russia and Central Asia Macroeconomic Outlook Introduction Central Asian economies have started recovering after a downturn in 215 and 216 due to unfavorable external conditions that have affected the countries of the region. Growth is attributed to the rise in commodity prices and stronger performance of the largest regional economies. Stabilization of the current account balance in most of the countries is expected to improve consumer and business confidence, pick up investments and drive the growth of domestic demand. Consequently, the majority of regional economies are expected to show stronger performance in 217 and 218, led by Armenia, Kazakhstan, Turkmenistan and Uzbekistan. 15 GDP growth, % ( f) E 217F 218F Source: IMF, Samruk Kazyna Armenia Belarus Kazakhstan Kyrgyz Republic Russia Tajikistan Turkmenistan Uzbekistan The IMF estimates economic growth in the Central Asian region at 2.4% in 216,.8% lower than in 215. Overall growth in the region is projected to pick up to 3.1% in 217 and further accelerate to 4.1% in 218. Kazakhstan, the largest economy in Central Asia, is expected to be one of the faster growing countries in the region, benefitting from a rebound in commodity prices and further fiscal stimuli, which have been proposed by the government. A similar situation can be observed in both Turkmenistan and Uzbekistan. Other countries of the region, which are more dependent on remittances and capital inflows form the neighboring Russia and China, are expected to achieve a more stable external balance. Nominal GDP and GDP per capita (216e) 9, 8, 7, 6, 5, 4, 3, 2, 1, Nominal GDP, USD bln Armenia Belarus Kazakhstan Kyrgyz Republic Tajikistan Turkmenistan Uzbekistan Source: IMF, Samruk Kazyna 5

6 Jan-14 Mar-14 May-14 Jul-14 Sep-14 Nov-14 Jan-15 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov-16 Jan-17 Mar-17 May-17 Jan-14 Mar-14 May-14 Jul-14 Sep-14 Nov-14 Jan-15 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov-16 Jan-17 Mar-17 May-17 Russia and Central Asia Macroeconomic Outlook 217 In 215 and 216, most of the Central Asian countries have devalued their currencies due to extensive external shocks and the devaluation of the Russian currency, since Russia is a significant trading partner or a source of capital inflows for most of the region s economies. This has triggered various fiscal and monetary shocks, increasing external debt and inflation. As countries continue to move toward increased exchange rate flexibility, their respective economies adjust to the new environment, while weaker currencies boost competitiveness of local producers. Fiscal support and currency adjustment helped mitigate some of the impact of external shocks. Exchange rates of regional currencies, % (Jan-214 as 1%) 26% 24% 22% 2% 18% 16% 14% 12% 1% AMD BYR KZT KGS RUB TJS TMT* UZS* Source: Bloomberg, Samruk Kazyna Note: Turkmenistan Manat and Uzbekistan Som are not traded at market value Russia, Kazakhstan, Turkmenistan and Uzbekistan have commodity-oriented economies, which depend heavily on global prices. Oil, gas and several other commodities have seen a significant drop in prices since early 215, which has put some pressure on current account balances of these countries. Oil prices, which are a major source of export revenue for Russia and Kazakhstan, starter to rebound slightly in 2Q16 and are poised for stabilization at around USD5-52pb in the medium-term. While such price levels are significantly below pre-214 highs, they should support external balances of several Central Asian economies. Bloomberg commodity index (Jan-214 as 1%) Bloomberg commodity index Brent, USDpb (RHS) Source: Bloomberg, Samruk Kazyna 6

7 A r m e n i a B e l a r u s K a z a k h s t a n K y r g y z s t a n R u s s i a T a j i k i s t a n T u r k m e n i s t a n U z b e k i s t a n Russia and Central Asia Macroeconomic Outlook 217 In addition, Central Asian economies are expected to benefit from higher growth in the region s largest economies. Perspectives of the Russian economy have improved, since the country is expected to resume growth in 217. Russia is the key driver of remittance flows and the largest trade partner for most of the economies of the Central Asian region. At the same time, growth of the Chinese economy, a key investor and increasingly important trade partner for the region, is forecasted to remain strong. This positively affects growth perspectives of Central Asian countries through improved capital and trade flows, as well as through higher commodity prices. One of the most promising economic developments in the region is the Chinese One Belt One Road initiative, which will focus on strengthening connectivity and promoting infrastructure development. Gross government debt and fiscal balance, % of GDP (216e) Gross debt Fiscal balance Source: IMF, Samruk Kazyna Nevertheless, most economies of the region are still facing internal and external imbalances, which require adequate response from the governments through monetary, fiscal and structural policy measures. One of the largest problems for the majority of the regional economies is rising government debt and diminishing fiscal space. With the exception of a few countries, the governments used fiscal stimuli to offset the impact of external shocks. While this provided some support to economic activity, fiscal space has declined and public debt is now higher. Some countries would have to implement further fiscal consolidation, adopt more accommodative monetary policy and enforce institutional reforms to ensure a fast recovery and sustainable growth in the future. In addition, the economic slowdown, coupled with exchange rate depreciation, had an adverse impact on the heavily dollarized financial sectors of the Central Asian economies. Inefficient banking sector is a big impediment to future growth. Consequently, medium-term growth in the region is expected to remain below the historical average, reflecting a relatively subdued external outlook, and domestic structural problems. 7

8 1Q7 1Q8 1Q9 1Q1 1Q11 1Q12 1Q13 1Q14 1Q15 1Q16 1Q17 Russia and Central Asia Macroeconomic Outlook Kazakhstan Kazakhstan s economy remains resilient; it has withstood shocks from low oil prices, devaluation of the tenge and growth slowdown in key trading partners. The economy is gradually adapting to the new normal environment. For 216, GDP growth stood at 1.%, above official forecast of.5% and beating market expectations of as low as -1.%, supported by gradual recovery in oil prices towards 4Q16, the resumption of oil output from Kashagan and infrastructure spending. The government s fiscal stimulus packages (transfers from the National Fund to the budget amounted to 6% of GDP in 215 and 8% of GDP in 216) had cushioned the declines in private sector consumption and investment. For 217, GDP growth is expected to strengthen up to 2.5%, supported by higher global oil prices, increase oil production, continued fiscal stimulus and improved economic performance in key trading partners. The government allocated KZT441.6bln for the implementation of Nurly Zhol program in 217 with the possibility of an increase to KZT72bln subject to budget revision depending on the economic situation. These funds will be used for the construction and reconstruction of infrastructure including highways, railways and airports. Other measures include construction of affordable housing, as well as projects for the EXPO 217. These measures are expected to have a multiplier effect on the economic growth. In the medium-term, GDP growth will hover at 3.1% and 3.5% between 217 and 222, in line with the Ministry of Economy s projections Quarterly GDP Growth Trend, % YoY (27-216) Source: Ministry of National Economy, Samruk Kazyna A sectoral review of 216 results showed that growth momentum was supported by construction (7.9%), agriculture (5.5%), transportation services (3.7%), as well as manufacturing (.7%). At the same time, growth last year was dragged down by a slowdown in the mining (-2.7%), retail and wholesale trade (- 1.4%) and communication (-2%) sectors. Overall volume of produced goods increased by 1.3%, while the volume of services grew by only.8%. Consequently, production of goods contributed more to GDP growth than services for the first time since 21. Consequently, in 216, Kazakhstan s economy became slightly less dependent on commodity sectors. The slowdown in mining was due to the decreased production of crude oil (-1.8%), coal and lignite (-4.9%) and iron ores (-12.9%). The decline in iron ore output was due to a drop in Chinese demand for iron ore and pellets, decrease in exports of pellets to Russia, and decline in world prices for iron ore. The manufacturing sector recorded a growth rate of.7% in 216, up slightly from.5% in 1H16. Metallurgy (6.6%) and production of food products (3.9%) contributed most to this output increase. 8

9 Russia and Central Asia Macroeconomic Outlook 217 Investment in fixed assets provided some support for the economy, the physical volume of expenditures on construction, capital investments, as well as machinery and equipment grew by 5.1%. The total volume of investment in fixed assets in 216 was estimated at KZT7.7tln. GDP Growth Breakdown by Sectors, % ( ) Industry Mining Manuf'g Const'n Agriculture Source: Ministry of National Economy, Samruk Kazyna 217f 216 Economic growth in 216 was higher than the official forecast of.5%, mainly attributed to the implementation of the state infrastructure development programs, as well as the construction of affordable housing within the Nurly Zhol initiative. Consequently, construction alone contributed more than 5% of the observed economic growth in 216. At the same time, the commissioning of the Kashagan oilfield in 4Q16 alongside the recovery in global oil prices towards the fourth quarter also boosted growth for the year. External environment improved throughout the year, which helped stabilize the national currency. Decreasing inflationary pressure and the subsequent gradual reduction of the base rate from 17% to 12% by the NBK towards the end of last year helped accelerate economic growth. Consequently, growth in 1Q17 exceeded forecasts and amounted to 3%, but this attributable to a low base effect of 1Q16. Fiscal position Consolidated budget revenues are expected to increase in 217 to KZT9tln or 18.1% of GDP vs. KZT8.1tln or 17.8% of GDP in 216. The main increase in revenues is expected from corporate income tax and value-added tax due to an improvement in the overall economic performance. At the same time, budget oil revenues are also expected to increase to KZT2.4tln mainly due to an improvement in the oil price outlook from USD35pb to USD5pb and additional production at the Kashagan oilfield. Oil production forecast for 217 was revised up to 81mln tons vs. 78mln tons in 216. Planned consolidated budget expenditures for 217 amount to KZT12.8tln or 22.3% of GDP. One of the largest expenditure items is the rehabilitation of the banking sector, which will require as much as KZT2tln, of which the National Fund will finance KZT1.1tln. These expenditures are needed to support the largest banks and stimulate lending to the economy. KZT231bln are allocated for technological modernization of the economy and improving the business environment in specific sectors, including KZT6 billion for the development of the agricultural sector and KZT127bln for the development of transport and transit potential. 9

10 Russia and Central Asia Macroeconomic Outlook 217 Consequent implementation of the government infrastructure development plans and additional anticrisis measures in 217 would require a target transfer from the National Fund in the amount of KZT1.5tln, previously KZT1.1tln. The target transfer in 216 amounted to only KZT.7tln. At the same time, the consolidated budget would receive KZT2.9tln in guaranteed transfers. As a result, planned budget deficit in 217 was revised upwards by 2.7 times to (KZT3.8tln) or -7.6% of GDP vs. a deficit of (KZT2.1tln) or -4.5% of GDP in 216. Non-oil deficit will further increase to (KZT6.2tln) or -12.4% of GDP from (KZT3.8tln) or -8.4% of GDP. 1, 8, 6, 4, 2, Consolidated Budget Position, KZT bln ( ) Oil & Non-Oil Revenues Revenues, Expenditures & Budget Balance 15, 1, 5, f Oil revenue Non-oil revenue Source: Ministry of National Economy, Samruk Kazyna -5, f Revenues Expenditures Deficit Despite the unfavorable external environment and the overall economic slowdown, Kazakhstan s fiscal position remains strong enough to support fiscal stimulus programs. Resources of the National Oil Fund allow the government to execute massive infrastructure projects (assets of the National Fund stood at USD73.3bln or 53.7% of GDP as at end of 216). According to official projections, with oil prices at a conservative level of USD5pb, National Fund assets are expected to remain robust at USD66.5bln or 44.1% of GDP by the end-217. This provides some fiscal space, since government debt including government guaranteed debt remains relatively low at USD14bln or 1.5% of GDP as at end-3q16. Inflation and monetary policy In line with our earlier expectations of monetary policy for stimulus, National Bank of Kazakhstan (NBK) cut its base rate four times by a total of 5bps last year, from 17% in February to 12% in December. In February 217, the key interest rate was cut by another 1bps to 11%. The decisions on the base rate in 216 and February 217 were taken premised on the following factors: Inflation trends have corresponded to the expectations of NBK, with the risks of acceleration being minimal under current circumstances. In January 217, inflation stood at 7.9% YoY, within the official target band of 6.%-8.% for 217. In the absence of negative shocks, inflation is expected to reach 6.5%-7.% towards December 217, lowering to 5.%-7.% in 218 and potentially heading below 4.% by 22. The USD-KZT exchange rate has stabilized since March 216, reflecting the combination of an improved external and domestic environment, with the exception of the short-term turbulence in the global financial markets created by Brexit in June 216. Global oil prices improved significantly since 4Q16, providing the added support needed by the tenge. Similarly on the domestic front, improved economic stability reduced the negative expectations on currency risks. These 1

11 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 Russia and Central Asia Macroeconomic Outlook 217 developments have contributed to the conversion of foreign currency denominated assets to tengedenominated assets in both the foreign exchange cash market and the bank deposit market. NBK highlighted that further actions on the base rate will depend on the dynamics of fundamental factors influencing domestic demand and stability of the financial sector. Amongst external factors that should also be monitored include volatility of global commodity prices, speed of economic recovery in key trade partners and the revision of budget expenditures. External positions On external trade, total trade turnover decreased by 19.2% YoY to USD65.5bln in 216, whereby exports fell 19.9% YoY to USD37.25bln and imports contracted 17.8% YoY to USD27.8bln. The decline in exports was due to lower commodity prices while lower imports was driven by weaker purchasing power arising from slower growth, lower incomes and the devaluation of the tenge. Consequently, current account deficit was at USD8.17bln or 6.9% of GDP in 216, a second year the country registers a current account deficit since 29. For 217, total trade turnover is projected to improve by approximately 19.5% YoY to USD77.75bln, with exports and imports expected to increase by 21.% YoY and 17.6% YoY respectively, underpinned by stronger global growth, gradual recovery in commodity prices and improved economic performance from key trading partners. As such, current account balance is anticipated to improve further to USD5.91bln or -3.9% of GDP in 217. Kazakhstan s total trade turnover is projected to increase moderately in the medium-term, potentially reaching USD9bln by 221. Following this, current account balance is expected to improve gradually from -3.9% of GDP in 217 to -1.6% of GDP in 221. External Trade Trend, USD bln ( ) Exports Imports Trade balance (RHS) Source: Ministry of National Economy, Samruk Kazyna On reserves, Kazakhstan s official international reserves comprise of foreign-exchange assets at the NBK and in the National Oil Fund. Total international reserves stood at USD9.78 billion as at December 216. This amount comprised of FX reserves of USD29.76bln at the NBK and USD61.2bln at the National Oil Fund. NBK s repayment of FX swaps to commercial banks in 216 (at KZT6bln or approximately USD1.8bln) improved the quality of these reserves. 11

12 Russia and Central Asia Macroeconomic Outlook 217 Foreign direct investment Gross inflows of FDI picked up momentum in 216, amounted to USD2.64bln, USD5.89bln or 39.9% higher than in 215. Between 25 and 216, Kazakhstan attracted cumulative FDI of more than USD28bln. Inflow of investments went to traditional sectors, such as mining with total investments of USD65.95bln or 27.1% (mainly in the extraction of crude petroleum and natural gas), as well as investments into professional, scientific and technical activities at USD86.95bln or 35.8% (majority relates to geological exploration and prospecting activities). The oil and gas, natural resources and extractive industries continue to remain the most attractive sectors for investments, comprising more than half of Kazakhstan s accumulated FDI inflows to-date. Nonetheless, the manufacturing, wholesale and retail trade, financial services, and construction attracted commendable investments of USD29.99bln (12.3%), USD21.6bln (8.9%), USD12.17bln (5.%) and USD8.53bln (3.5%) respectively, reflecting relative success of Kazakhstan s efforts to diversify the economy. Gross Inflows of FDI, USD mln (25-216) 35, 3, 25, 2, 15, 1, 5, Source: National Bank of Kazakhstan, Samruk-Kazyna Netherlands remains the largest investor (domiciled by country) in Kazakhstan with investments amounted to USD71.67bln, while the US has USD27.22bln investments in the country. Other major investors include Switzerland, China, France, UK and Russia. Kazakhstan has increasingly been receiving FDI from China namely within the Chinese One Belt, One Road initiative. New Asian partners such as China, India and even Iran are replacing Kazakhstan's traditional investment partners. However, they have not been able to fully substitute Russia and western investors, many of which have been deterred by lower oil prices, weakening domestic and regional economic cycles. 12

13 Russia and Central Asia Macroeconomic Outlook 217 FDI by Sector (as at 216) FDI by Country (as at 216) 4% 7% Prof, science & tech 36% Mining & 5% quarrying Manufacturing 9% Wholesale & retail trade Financial services 12% Construction 27% Others 2% 2% 4% 23% 4% 5% 6% 6% 7% 3% 11% Netherlands US Switzerland China France UK Russia BVI Italy Japan Others Source: National Bank of Kazakhstan, Samruk Kazyna 217 outlook In summary, Kazakhstan s economy remains resilient and is gradually adapting to the new normal environment. GDP growth stood at 1.% in 216, above official forecast of.5% and beating market expectations of as low as -1.%, supported by gradual recovery in oil prices towards 4Q16, the resumption of oil output from Kashagan and infrastructure spending. The government s fiscal stimulus packages had cushioned the declines in private sector consumption and investment. For 217, GDP growth is expected to strengthen up to 2.5%, supported by higher global oil prices, increase oil production, continued fiscal stimulus and improved economic performance in key trading partners. The government allocated KZT441.6bln for the implementation of Nurly Zhol program in 217 with the possibility of an increase to KZT72bln subject to budget revision depending on the economic situation. These funds will be used for the construction and reconstruction of infrastructure including highways, railways and airports. Other measures include construction of affordable housing, as well as projects for the EXPO 217. These measures are expected to have a multiplier effect on the economic growth. Future performance of China and Russia will have spillover effects to Kazakhstan through trade and commodity prices, as well as through the degree of confidence and volatility in financial markets. China and Russia account for 11% and 1% respectively of the country s total exports, and more-thanexpected slowdown in China s economy and prolonged economic recession in Russia will put downward pressure on Kazakhstan s GDP growth. In addition, devaluation of the currencies of key trade partners especially the ruble will weigh on the competitiveness of the Kazakh exports and may result in downward pressure on the USD-KZT exchange rate with the risk of increased dollarization. 13

14 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 Russia and Central Asia Macroeconomic Outlook Russia In 216, Russian economy showed mixed results. The government tried to find balance between addressing economic problems and reaching social development goals. The dynamics of key indicators remained heterogeneous. On one hand, industrial production continued to grow, supported by an increase in external demand and the development of import substitution. Investment activity started to improve gradually. On the other hand, consumer demand continued to contract after a slight increase in the third quarter Real GDP growth, % ( ) Source: Federal State Statistics Office of Russia, Samruk-Kazyna Most of the socio-economic indicators remain negative at the beginning of 217 in continuation of the crisis that started in 214. However, almost all negative trends in the economy seem to be showing signs of improvement, while some sectors show impressive growth. Consequently, the economy of Russia has adjusted to the negative external macroeconomic environment although internal structural imbalances remain. GDP per capita, USD (21-216e) 18, 16, 14, 12, 1, 8, 6, 4, 2, e GDP grew.3% YoY in 4Q16, following.4% contraction in 3Q16. It was the first expansion in almost two years. Such growth can be attributed to an improvement in net external demand, as exports rose by 3.7% YoY while imports edged up.3% YoY. At the same time, household spending (-3.2% in 4Q16 vs. -4.8% in 3Q16) and investments (-.3% in 4Q16 vs. -.8% in 3Q16) contracted at a slower pace. 14

15 Russia and Central Asia Macroeconomic Outlook 217 Meanwhile, government consumption fell by.5%. Despite the positive results in 4Q16, GDP for the entire 216 shrank by.2% against -3.7% in 215. Consequently, GDP in current prices amounted to RUB86.44tln. Dynamics of the main sectors of the Russian economy, % ( ) Agriculture Mining Manufacturing Construction Retail and wholesale Real estate Source: Federal State Statistics Office of Russia, Samruk-Kazyna A sectoral overview of the Russian economy shows that real estate and renting services grew by 1.2% vs..7% in 3Q16; transport and communication expanded by 1.2% from.3% in 3Q16; financial services increased by 1.7% from -1.9% in the previous quarter while agriculture grew by a mere 3.2% vs. 5% in 3Q16. Output fell less in wholesale and retail trade (-.6% from -4.8% in 3Q16) and construction (-1.9% vs. -3.5% in 3Q16). In contrast, manufacturing contracted by.6% (1.3% in 3Q16) and mining and quarrying edged down.1% (.1% in 3Q16). Russia s agriculture, forestry, light manufacturing and chemical industries, as well as production of machinery and equipment experienced growth in 216, backed by large-scale state support measures and increased competitiveness of Russian producers due to the devaluation. The growth of output in manufacturing and agriculture contributed to an increase in transportation services, including through the expansion of exports. The policy of import substitution, launched in , also contributed to the growth of the aforementioned sectors. Moreover, in 216, the government put more emphasis on the development of the high-tech sector, including defense and aerospace subsectors. At the same time, traditional manufacturing sectors, such as metallurgy, were going through a difficult period due to declining domestic and external demand. Construction industry was also heavily affected by falling household income and lack of investments. As the economy adjusts to the new environment, growth is expected in more sectors in 217 compared with last year. 15

16 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 1Q17 11,36 12,586 13,45 13,93 13,897 14,64 Russia and Central Asia Macroeconomic Outlook 217 Investments in fixed assets, RUB bln ( ) Source: Federal State Statistics Office of Russia, Samruk-Kazyna Retail and wholesale trade, as well as several other service industries continued to decline (-5.2%) in 216 due to falling real incomes. The rate of decline, however, slowed in 215, the volume of retail and wholesale trade fell by 1% YoY. Wages and other income started to fall in 214, this trend is still evident three years later, in 216, despite an increase of.6% in real wages, real disposable income declined by 5.9% YoY due to a reduction in welfare and other social support. The falling of real incomes accelerated from 3.2% in 215 and.7% in 214. In 1Q17, real incomes declined by only.1% YoY, partially due to the low base effect of 216. In these conditions, the population continued to shift towards savings rather than consumption. As a result, most service industries continued to decline or showed insignificant growth. Household spending on final consumption decreased by 4.5% in 216, although the rate of decline slowed considerably from 9.6% in 215. Real disposable income per capita, % YoY (213-1Q17) Source: Federal State Statistics Office of Russia, Samruk-Kazyna Nevertheless services PMI in Russia indicated continuous expansion since February 216, reaching 58.4 points in January 217. Russia Services PMI for 1Q17 came in at 56.8, up on already significant growth in 4Q16 at 54.6 and significantly above the 1Q16 reading of 5. Such optimistic data shows that service industries may be on a path to recovery given consistent and sustainable increase in consumer 16

17 Jul-14 Sep-14 Nov-14 Jan-15 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov-16 Jan-17 Mar-17 May-17 Russia and Central Asia Macroeconomic Outlook 217 demand. PMI in manufacturing indicated slower but continuous expansion since August 216. Russia Manufacturing PMI averaged 53.2 in 1Q17, unchanged on 4Q16 and up on 49.1 average for 1Q16. 6 PMI in manufacturing and services (July 214-May 217) Manufacturing Services Threshold Source: Bloomberg, Samruk-Kazyna Several other macroeconomic indicators are suggesting that the Russian economy is on its path to recovery. Consumer and business confidence has been improving, standing at the highest level in the last five years. Consumer confidence in Russia rose to -15 in 1Q17 from -18 in 4Q16. It was the highest reading since 3Q14. Households showed less pessimism about Russia s economic situation over the next 12 months. The consumer sentiment in regards to personal financial situations and conditions for major purchases showed improvement in 1Q17. Government policy Recession in the Russian economy called for several structural reforms from the government. First of all, the authorities carried out several privatization initiatives that became the key source of funding for the state budget and ensured that the country would be able to overcome the negative effects of the Western financial and economic sanctions. The sale of 19.5% stake in Russia s energy giant Rosneft to foreign investors was one of the largest privatizations carried out in the last several years. Further privatization initiatives might be launched in 217. The government is making more steps to encourage competition on the domestic market, as well as support import substitution. Improvement of the business climate has positively affected businesses: despite the overall economic downturn the country s stock market is growing rapidly while the price of national companies shares has grown by 27% in 216. Other anti-crisis measures included diversification of the economy via subsidies and targeted support of various sectors, such as automotive industry and several manufacturing subsectors. At the same time, the government allocated more than RUB3bln for the social development of regions and other social security programs. Total cost of the program amounted to about RUB7bln. The anti-crisis program for 217 is far smaller in scope (RUB11bln), but essentially it follows the same principles. The plan consists of 16 measures and focuses on supporting individual industries: the automotive industry, transportation, agriculture, construction, road and municipal engineering, machine building, as well as the food, light manufacturing and processing industries. Most of the funds are 17

18 Russia and Central Asia Macroeconomic Outlook 217 allocated to the automotive industry - more than RUB62bln. These funds will be directed on subsidies for automakers and auto loans to stimulate demand for domestically-produced vehicles. However, experts argue that the government should prioritize structural reforms, aimed at improving competitiveness rather than subsidizing vulnerable industries. One of the key measures in this direction is the reduction of government support for inefficient enterprises with low labor productivity, which will create conditions for the reallocation of resources, capital and workforce into more efficient companies. Fiscal policy Since January 1 217, the Russian government has shifted to a three-year budget planning. Previously, in 216, the government used a one-year budget due to a high degree of uncertainty in regard to the external and internal macroeconomic conditions. Planned federal budget revenues in 217 are estimated at RUB13.5tln, while expenses should amount to RUB16.2tln. Consequently, the deficit of the federal budget in 217 is anticipated at RUB2.8tln (3.2% of the GDP), which is slightly lower than the RUB2.95tln deficit in 216. The government plans to reduce this amount to RUB2tln in 218 and just RUB1.1tln in 219. Government budget deficit, % of GDP (21-216e) e General government revenue General government total expenditure The budget was prepared using the base case scenario with an average annual oil price of USD4pb and inflation of no more than 4%. Exchange rate forecast stands at 67.5 rubles per US dollar in 217, 68.7 rubles per US dollar in 218 and 71.1 rubles per dollar in 219. The ministry of finance estimates that if the average oil price in 217 will be around USD55pb, exchange rate will stand at RUB66.3 per USD and the budget deficit will amount to just 1.5% of GDP. 18

19 Russia and Central Asia Macroeconomic Outlook 217 Structure of budget revenues, % (216) 5% 1% 5% 37% 7% 36% Oil & gas revenues VAT Excise taxes Use of public property Income taxes Other Source: Russian Ministry of Finance, Samruk-Kazyna In 216, the budget deficit was partially financed using the assets of the Reserve Fund, which have decreased to about RUB3tln by the end of 216. However, in 217 this fund is expected to be depleted, consequently, budget deficit in 217 will be financed using the National Welfare Fund (NWF), whose assets are forecasted at RUB4.7tln as at the beginning of 217, RUB4.2tln in 218 and RUB3.1tln in 219. In general, the government is planning to reduce external borrowing and switch to domestic borrowing. Sources of budget deficit financing, % (216) 3% 23% 39% 35% Reserve fund Domestic borrowing NWF Other borrowing Source: Russian Ministry of Finance, Samruk-Kazyna About 5% of the budget will be allocated on public administration, national security and the financing of the government s economic projects, as well as on subsidizing state entities, another 3% will be spent on pensions and social payments. Other expenditures include separate subsidies to the regional budgets to decrease regional disparities. Budget sequestration resulted in decreased financing of healthcare and education, their weight in total 217 budget expenditures decreased to 2.3% and 3.5% respectively. The government has also decreased its military budget by 6% in real terms. Unlike the 216 fiscal policy, newly adopted budget is more socially-oriented. 19

20 Russia and Central Asia Macroeconomic Outlook 217 Inflation and monetary policy Throughout 216, the Bank of Russia has been carrying out a strict monetary policy that has helped to bring down the inflation. The key interest rate has been lowered from 11% at the beginning of the year to 1% by end-216. Consequently, the inflation rate decreased from 14.5% YoY in 4Q15 to 4.6% YoY in 1Q17. April 217 s CPI growth was the lowest inflation rate since May 212, as prices increased at a slower pace for housing and utilities, clothing and transport. 118 Quarterly inflation, % YoY (1Q14-1Q17) Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 1Q17 Source: Federal State Statistics Office of Russia, Samruk-Kazyna As the inflation approached the regulator s target, the central bank has lowered its benchmark oneweek repo rate further by to 9.75% in March 217 and 9.25% in April 217. Policymakers signaled the possibility of further cuts in 3Q17 and 4Q17, as inflation continues to decline and is projected to reach 4% target before the end of 217. Since the CBR shifted to a free-floating regime and inflation targeting, it emphasizes predictability, transparency and better communication as core principles. Given the favorable external conditions, Bank of Russia may decrease the key interest rate to the level of % to stimulate the domestic economy. The Bank estimates that the economy continued to recover in the first quarter and expects fixed capital investments to increase. Industrial production is maintaining positive dynamics and unemployment is showing a downward trend. The labor market is adjusting to the new economic environment, with signs beginning to emerge that labor shortages are finding their way in individual segments. According to the estimates, the observed annual rise in real wages will foster gradual growth in consumer activity without posing additional pro-inflationary pressure amid increased supply of goods and services. Among other measures undertaken by the regulator in 216, the Bank of Russia revoked licenses from 95 banks, or about 1% of total, in order to stabilize the banking system and make it more resistant to various shocks. External conditions: FX rates, reserves and trade Russia s central bank maintained its free-float regime for the national currency throughout 216 to help the economy adjust to external shocks, such as falling oil prices and Western sanctions. Improvement of the external environment has resulted in a 19% appreciation of the Russian currency as compared to the US dollar. The strengthening of the ruble on the back of a stable external economic environment 2

21 Jan-16 Feb-16 Mar-16 Apr-16 May-16 Jun-16 Jul-16 Aug-16 Sep-16 Oct-16 Nov-16 Dec-16 Jan-17 Feb-17 Mar-17 Apr-17 Jan-16 Feb-16 Mar-16 Apr-16 May-16 Jun-16 Jul-16 Aug-16 Sep-16 Oct-16 Nov-16 Dec-16 Jan-17 Feb-17 Mar-17 Apr-17 May-17 Russia and Central Asia Macroeconomic Outlook 217 has also contributed to the slowdown of inflation in Russia, holding back prices for non-food goods and services. RUBUSD exchange rate vs. interest rate (January 216 May 217) RUBUSD Interest rate Source: Bank of Russia, Samruk-Kazyna After several unexpected spikes in 1Q16, Russian ruble s exchange rate remains stable at the level of rubles per US dollar. The Russian ruble has also been among the best-performing emerging market currencies during 1Q17 with gains of about 9% after further growth of oil prices. However, it has depreciated by about 2% in April , 4, 395, 39, 385, 38, 375, 37, 365, 36, 355, 35, Foreign exchange reserves, USD mln (January 216 April 217) Source: Bank of Russia, Samruk-Kazyna Russian financial markets posted a stellar performance in 216 and ended up surprising most market participants. The Russian ruble also rose sharply, enhancing the profitability of local-currency investments in 216. It also supported the inflow of money from non-residents, further increasing the attractiveness of Russian equities and bonds. Foreign investment in Russian equities stood at USD3bln in the first three quarters of 216 as compared to an outflow of about USD.3bln in the same period last year. 21

22 Jan-16 Feb-16 Mar-16 Apr-16 May-16 Jun-16 Jul-16 Aug-16 Sep-16 Oct-16 Nov-16 Dec-16 Jan-17 Feb-17 Mar-17 Apr-17 Russia and Central Asia Macroeconomic Outlook , Gross inflow of FDI, USD mln (1Q14-4Q16) 2, 15, 1, 5, -5, 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 Source: Bank of Russia, Samruk-Kazyna The increase in FDI in Russia is principally attributed to investments associated with the privatization of state-owned assets: the government sold a 19.5% stake in the state-owned oil company Rosneft in a deal worth around USD11bln to a consortium led by Glencore (Switzerland) and the Qatari sovereign wealth fund 6, Exports and imports, USD mln (January 216 April 217) 5, 4, 3, 2, 1, Exports Imports Turnover Source: Federal State Statistics Office of Russia, Samruk-Kazyna The foreign trade turnover of Russia in 216 amounted to USD471.2bln dollars. This is 11.2% less than in 215. The devaluation of the ruble played a decisive role in the reduction of external trade. The exchange rate in the beginning of 216 skyrocketed to 78 rubles per US dollar. This coincided with a seasonal decline in business activity in January, which is observed in Russia annually, as well as with a reduction of production in many manufacturing industries. As a result, volumes of trade in January reached record lows - exports fell by one third, while imports declined by 2%. 22

23 Russia and Central Asia Macroeconomic Outlook 217 Over 216, Russia's exports in declined by 17% to USD285.49bln. Such dynamics is due to lower oil and commodity prices. At the same time, exports in volume terms increased, consequently Russia increased exports abroad even in unfavorable conditions. As such, oil exports in 216 increased by 6.6% to mln tons, while revenues from exports of oil fell by 17.7% to USD73.67bln. Exports of other conditions followed the same trends. Russia has also increased exports of many food products, machinery and other manufacturing products to China, Asia and Europe. The devaluation of the ruble allowed Russian products to compete efficiently in external markets. Unlike exports, both monetary and physical volumes of imports showed a decline. Imports of motor vehicles, electric generators, textiles, and foodstuffs have decreased due to the depreciation of the ruble, as well as lower consumer demand and a decline in industrial production in a number of industries. The current account balance of Russia in 216 declined to USD25bln (USD68.9bln in 215). The net capital outflow by the private sector amounted to USD19.2bln, or one-third of the outflow in 215. This was mostly due to a reduction in external debt repayments by banks, while the government continued external borrowing. The external debt as of January 1, 217 amounted to USD513.5bln, declining by USD5.6bln or 1.1% over 216. Outlook for 217 The IMF upgraded its forecast on Russia s GDP growth from 1.1% to 1.4% in 217 and from 1.2% to 1.4% in 218. Improved outlook for the economy reflects firming oil prices and a recovery in domestic demand attributable to easing financial conditions and improved consumer confidence. Inflation is expected to slow down further in line with the central bank s inflation target, providing the conditions for the central bank to gradually resume monetary policy easing to stimulate credit growth. However, Appreciation of the ruble that started after the rebound in global oil prices may limit the competitiveness of Russian producers and negatively affect growth prospects. At the same time, the fiscal consolidation process in Russia is expected to continue to adjust to lower oil revenues and increased social obligations. This could limit the government s fiscal space needed for the support of the economy. In the medium term, the growth potential of the economy will depend on the implementation of structural reforms. These reforms should be aimed at promoting competition in markets, modernizing production capacities. Higher oil prices and the improved outlook for Russia will support activity in other countries of the region, given tight linkages through trade, investment, and remittances. 23

24 Russia and Central Asia Macroeconomic Outlook Armenia According to official forecasts, GDP growth in Armenia slowed to.2% in 216 due to falling agriculture (-5.8%), construction (-11.8%) and communication (-2.2%). On the other hand, such sectors as mining and manufacturing registered growth of 11.6% and 5% respectively. Such growth was not enough to outweigh the decline in agriculture, which is the largest sector of the Armenian economy with 15.9% of the GDP. Consequently marginal growth of the economy was supported by services and retail and wholesale trade which grew by 1.9% in total. Other factors that negatively affected growth in 216 include a result of a significant reduction in government spending in the second half of the year, weak household demand and a deep contraction in investment. In early 217, economic activity has shown signs of recovery, led by private sector credit growth supported by monetary policy easing. GDP growth of Armenia, % (21-217f) e 217f Unemployment is one of the largest problems in Armenia, a large part of the population works on seasonal jobs in the agriculture industry. The unemployment rate in Armenia decreased to 17.4% in 4Q16 compared to 19.5% in the previous period. It was the lowest jobless rate since the third quarter of 215 as the number of unemployed persons fell by 41.1 thousand to thousand. Nevertheless, the level of unemployment in 216 increased to 18.8% vs. 18.5% in 215. The unemployment rate in Armenia is the highest among the CIS countries. In addition to unemployment, the wages in the country keep declining in both public and private sectors, pushing down the inflation in the country. Unemployment rate in Armenia, % (21-217f) E 217F Consumer prices in Armenia increased by 1.2% YoY in April 217, following a.1% drop in the prior month. It was the first rise in consumer prices since November of 215, driven by higher cost of food 24

25 Russia and Central Asia Macroeconomic Outlook 217 and non-alcoholic beverages (5.9% from 3.4% in March); transport (.7% from -1% in the previous period). Despite the upward spike in inflation, the underlying factors remain. Overall CPI in 1Q17 declined by.3% YoY after a 1.4% YoY decrease in 216. The deflation was due to subdued consumer demand, falling wages and lower imports prices for consumer goods. To stimulate economic growth and inflation, the Central bank of Armenia has made twelve rate cuts in the last 2 years from 1.5% to 6% as of February 217. Policymakers expect economic activity to recover and inflation to accelerate to around 2% in 217. Inflation in Armenia, % (21-217f) e 217f Armenian trade deficit declined from USD1.84bln in 215 to 1.51bln in 216 due to increased exports from 1.49bln in 215 to USD1.78bln in 216. Meanwhile, imports remained virtually unchanged due to subdued consumer demand. Nevertheless, the country holds a consistent trade deficit due to low export diversification and competitiveness. In 1Q17, trade deficit stood at USD36.6mln as exports went up by 16.5% to USD443.1mln while imports rose at a much faster pace of 17.9% to USD83.7mln. Armenian trade balance, USD mln (21-216) 6, 4, 2, -2, , Exports Imports Trade balance Source: Armenian Statistical Service, Samruk-Kazyna About 8% of exports are provided by four sectors mineral ores (26.4%), prepared foodstuffs (23.4%), precious and semi-precious stones/metals (18.9%), as well as non-precious metals (12.4%). Top ten importers of Armenian goods and services are: Russia (2.8%), Bulgaria (8.5%), Georgia (8.2%), Germany (7.8%), Canada (7.8%), Iraq (7.7%), China (5.4%), Iran (4.2%), Switzerland (4.2%) and the UAE (3.6%). In 216, exports to Russia and Bulgaria rose by 51.5% and 93.1% respectively, while exports to the UAE grew seven-fold. Exports to China decreased by 41.7% last year. 25